Arvind Mills Re-Evaluating Profitability

8/18/2019 Arvind Mills Re-Evaluating Profitability

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Arvina Mills Re Evaluating Profitability

ByRajeev Khera, under

t

supervision of Professor Murray J. Bryant

It was a typical, tropical June summer afternoon in

western India. The temperatures outside were soar-

ing to 45°C, and in his climate controlled environ-

ment, Mr. Bala, vice-president of operations,

knitwear division, atArvind Mills Limited, had been

thinking hard about a trial order from one of the

world s major ready-to-wear apparel retailers. .The

initial developments leading up to this trial order

had gone smoothly, and the company was confident

that it had more than adequately addressed all the

major concerns of this customer. The continued

communications to and from the customer reflected

this sentiment. In fact, the success of this trial order

was taken as a given, and management was planning

for the large volume of business that would, in all

probability, come their way.The entire deal hinged

upon the premise that the customer would accept

the prices that were going to be quoted on June 22,

1999,the followingMonday.

The importance of the right price was not in

the leastbit underestimated by Bala.He had carefully

Copyright

@ 2 4

Ivey Management Services

monitored each and every elemental cost of raw

materials and process, and had suggested tremen-

dous innovations on aspects that provided a con-

siderable reduction in costs, without compromis-

ing on the quality; delivery schedules; and other

critical metrics. And yet, the numbers he was

looking at today were not globally competitive-a

factborne out of the company s own market study.

Any further reduction in prices would render the

entire business un-profitable.

The choices to be made were stark and diffi-

cult. On the one hand was the option of quoting

the prices that had been worked out by the current

costing system-and lose the business to the com-

petition (mainly China) (see Exhibit 1). The other

option was to accept the business at the price of the

competition (ignore what your own costing is tell-

ing you), ensure continuing revenues and take a hit

on profitability-and hope that in due course, the

company would be able to negotiate better prices

and recover some of the lost profits.

Version: (A) 2009-10-08


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China

Hong Kong China)

India

99

16,889

23,619

4,709

60,000

50,000

40,000

2

§. 30,000

~

20,000

10,000

0

Arvind Mills: Re-Evaluating Profitability

75

995

37,967

35,112

8,468

999

43,121

34,642

10,240

52,206

37,656

11,929

2

53,476

35,660

13,897

1990 1995 1999 2000 2001

Year

1--

China --- Hong Kong China) -f:r- India I

Textile Industry in

India n

Overview

From the day India achieved its independence on

August 15, 1947 after about 200 years of the Brit-

ish Raj), until about 1986-87, the industrial poli-

cies of each successive government were guided by

the principles of socialist form of governance. The

governments enacted a labyrinth of laws, rules

and regulations, ostensibly to promote industrial

growth in a market environment that was pro-

tected to the greatest possible extent from external

competition.

The textiles and clothing industry is the largest

manufaCturing sector in India, accounting for

around four percent of GDP, 20 percent of India s

industrial output and 37 percent of total exports

WTO,1998).Textiles i.e.,yarn, cloth, fabrics and

including substantial segments of weaker sections of

society. Its growth and vitality, therefore, had critical

bearings on the Indian economy at large.

The dominant concerns of government policies

towards the cotton textile industry centered around

import substitution the credo of self-sufficiency).

Exports were considered a marginal outlet for sur-

pluses, protection of existing employment in the

organized big business) sector, support of the decen-

tralized small scale) sector, and protection of the

cotton farmers interests. These pre-occupations were

refleCted in the major government policies for this

sector such as:

.

extensive quota restrictions on vanous

product categories,

strong exit barriers, even for unviable oper-

ations to ensure continued employment),

.

.


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7

CHAPTER :

PRI IN

.

stringent licensing for the organized sector

at the expense of small and medium-scale

manufacturers.

These strict policies led to an extremely skewed

development of the Indian textile industry. The

large-scale industries were restrained at the expense

of the small-scale industries that prevented mod-

ernization, quality investments, scale adoption, and

change in product mix from exclusive reliance on

cotton garments to mass clothing items based on

synthetic and man-made fibers. Indian fiscal and

customs policy too discriminated against develop-

ment of synthetic base in India in line with the

government belief that synthetic is for the classes

and cotton is for the masses: As a result, while cot-

ton prices were not allowed to move up (trade

control, and buffer state operations), synthetic

fibers were deliberately priced at uncompetitive

levels (viewed as a luxury fiber for higher income

groups) against cotton.

In its development policies, the state discrimi-

nated against the mill sector in favor of the power-

loom sector, which was perceived as an engine of

growth. This was done through preferential import

and export quotas for the powerloom sector. As a

result, the powerloom sector flourished at the

expense of the other two.

Between 1977and 1986,the powerloom sector

more than doubled its capacity, reaching 800,000

looms, while the mill and handloom sectors lagged

behind. Government controls on scrapping obso-

lete equipment and restrictions on imported

machines resulted in further under-used capacity,

poor productivity, and loss in profitability.

Strong resistance from workers fearing job

losses prevented any technological changes and

internal restructuring in these two state-owned

textile sectors. This led to a loss of competitiveness,

rising operational costs, and a weak and sickly

industrial structure.

The degree of skewing became apparent in

the fact that the Indian textile and clothing indus-

I

consumer. Each contributed not only to the

lengthening of lead times, but also to additional

costs. By the time cotton worth INRlOOreaches

from farmer to the spinning unit, its cost inflated

to INRI48. By the time it reaches the final con-

sumer, it costsINR365.

The spate of broken links, exemptions avail-

able to various segmentssuch as smallscaleindus-

trial units that competewith exciseand duty pay-

ing segment, and disproportionate excise duty

incidence across the chain had become major

impediments to developingcompetitivenessin the

industry.Marketstructuresweredistorted,creating

unhealthycompetitionamong the segmentsthem-

selves,and succeedingin creatinga diversevariety

of vestedintereststhat are (eventoday) opposed to

any reformin the sector.

The global trade in textiles was also regu-

lated to a considerable degree, and access to

markets in the developed countries was not free

of protective tariffs and artificial barriers usually

in terms of quantitive restrictions. From 1974

and up to the end of the UruguayRound in 1994,

textile and clothing quotas werenegotiated bilat-

erallyand governedbythe rules of the multi-fiber

arrangement (MFA).Though this systemhad its

fair share of drawbacks, it did help transfer the

demands from the developed countries like

China and India.

With the Indian industry crying for reforms

to essentially ensure its survival, and sensing a

whiff of the opportunities in the markets abroad,

manufacturers met with the government to

embark on a long-term policy of liberalization

and earning export revenuesbecame a key thrust

area. The years 1986-87marked this key turning

point. The initial forays into the international

market weremade by the first generation, entre-

preneurial apparel (clothing) manufacturers.

Their abilities and resourcefulness brought a

number of international clothing majors such as

Levis,Benetton, Lacoste,and Pierre Cardin to the

Indian stores. Their gains also percolated down-


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The textile industry's restructure was helped

in large measure by the rapid devaluation of the

Indian rupee, and for the most part, it camouflaged

the lack of industry competitiveness and ensured a

steady growth.

The MFA was later replaced by Agreement on

Textiles and Clothing, a more rationalized system

that came into effect in 1995 at the Uruguay round

of General Agreement on Trade and Tariff (GATT),

giving further boosts to exports.

Arvind Mills Limited

With the current revenues at US 550 million,2

Arvind MillsLimited is the flagshipcompany of

LalbhaiGroup (Exhibit2). It was incorporated in

1931to manufacturecotton textiles.Operatingin a

highly regulated and protected market, the com-

pany grew to become one of the leading cotton

manufacturing companiesin the country,produc-

ing conventional suiting fabrics, shirting fabrics,

and sarees(traditional Indian robe).


Cashing in on its technical skillsand mana-

gerial capabilities, Arvind Mills undertook its

first expansion to manufacture denim. In 1986,

the company started to look for textiles that had

global demand, high margins, high entry level

barriers, (either of technology, expertise or

set-up costs) and, very importantly, low fashion

volatility. The company wanted to focus on fab-

ric that would never goout of style. Fromwithin

the possible products, denim proved to be most

suitable. From 1987 (at annual production

levels of three million meters), within 10 years,

Arvind Mills expanded to become the world's

third largestproducer of denim cloth at 120mil-

lion meters.

In 1993,a studyof sevencountriesfound that

the price of cotton yarn per kilo was cheapestin

Indiaat 2.79,comparedto 3.30in Brazil, 4.19in

Japan,and 3.10in Thailand.Thiswasthe resultof

overalllabor and rawmaterial costsbeingcheaper

in India. .

Spurred on by the successesin the denim

industry, Arvind Mills undertook substantial

Sales by Market Rs. in Crores

1997-98

1854

1998-99

1999-00

2000-01

18 Months

2400

2000

1600

1200

800

400

0

1996-97


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CHAPTER

PRICING

Sales and Operating Income

Rs. In Crores

1877

~

200

100

0

-100

-200

-300

-400

-500

-600

1996-97

1997-98

1998-99

1999-00

2000-01

18 Months

Profit Before Tax Rs. in Crores

133

109

-499

1997-98

1998-99

1999-00

2000-01

18 months

ourceCompanyiles

Conversion:

I Crore= 10million

US I = INR36

investmentsof millions of dollars into manufac-

turing other textilefabricsas:

.

knitted fabric 120million;and

apparel.

2100

1800

1500

1200

900

600

300

0

1996-97


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had other business interests in related and

non-related industries. One of the group s compa-

nies, Atul Limited ( 130 million), manufactured

chemicals and intermediaries for the textile, paper,

and leather industries. Another, Amtrex Appliances

Limited,manufactured and marketed household air

conditioners and had joint ventures with Hitachi

(Japan) and Fedders (United States).

Market Dynamics Increase

Toward Complexity

The fashion and textile market worldwide had wit-

nessed an immense transformation since 1990.

Moving from constant, non-volatile fashion trends,

major retailers, working with textile designers in

the fashion centers of the world, continually added

complexity to the products theytetailed in terms of

fabric color, composition, structure and styling of

the garments. The customer therefore was no lon-

ger buying out from the inventory they associated

with the manufacturers and the very initial stages

in the process of fabric manufacture. Tough com-

petition placed further pressures on the lead time

to market and development cycles; in fact, the

entire end-to-end logistics of the value chain was

bearing the pressures of such transformations.

Arvind Mills expansion kept pace with the

increasing complexity of the marketplace. The process

of manufacturing denim was relativelysimple. It had


79

fewer variables, a less complex product mix and rela-

tivelyeasylogistics in terms of process and workflow

(seeExhibit 3). The company was able to successfully

exploit the economies of scale, (thereby reducing per

unit overhead), the low price of cotton, and the power

in its supply chain. The growth was therefore relatively

smooth, controlled, and predictable. But the early

gains were being eroded due mainly to the increasein

cotton prices that more than doubled between March

1989and March 1993.Also,the worldwide demand in

denim reached a plateau, and the margins were being

squeezed out.

The product structure, the product mix, and the

logistics involved in the manufacturing processes the

other divisionswere, however,much more involved.

The apparel retailers and designers looked to

fabrics other than denim that offered more possi-

bilities in terms of color and structure to manufac-

ture trousers. Bo~tom weights became the next

logical step forward. Whereas the manufacturing

processes remained essentially similar, the logistics

had to address many more variations, production

run switches, different lot sizes, etc.

A recent addition to the range of fabric and

clothing came in the form of knitwear. The technol-

ogy,equipment, processes, material inputs, product

mix, and logistics were entirely different from those

currently followed to manufacture woven fabrics

such as denim, shirting or bottom weights.

The fabrics came in both tubular and open

widths, in single knits as jersey, pique, textures,

(Primarily

indigo/white)

yeing

ustomer


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8

CHAPTER PRI IN

pointells, fleece, French terry, jacquards in solids,

feeds, and automatics, and in double knits such as

interlocks, needle-outs, ottomans, thermals, poin-

tells, textures, reversible, jacquards, ribs in solids,

feeds and automatic collars, plains, and jacquards

(see Exhibit 4). These fabrics had applications

from casuals to formals, from active wear to sleep-

wear for men, women, children, and infants.

With somuch variation and range,the one thing

that stood out was the immense necessity to under-

stand and manage all specificationspertaining to each

and everyorder from the customer, and more impor-

tantly the need to havefastand clear communications

with the customers across the world. Arvind Mills,

sensingthisneed, setup a high-tech designcenter.The

centrewasnetworked globallywith designersto create

corpus of the finest international design. That linked

the designing facilityto a pilot mill;' and the designs

created on-screen wereduplicated on fabric in a mat-

ter of hours. This ensured that the customer got an

exclusive,world-classdesignin a very short time. This

process not only helped shorten design-to-market

IIB_-

lead-time; it also allowed the retailers and designers to

watch the trends closely and design and launch the

products close to the start of a season.

The potential order that Balawas looking at

was as follows:

Customer inputs,

communications,

feedback

Cotton, Polyester/Cotton Blends,

different staple lengths

Different counts fineness of yarn

Different colors: Black, navy, khakis,

greens, olives all custom-dyed

Different structures: jersey, pique,

jacquards, pointells, etc.

Different finishes stain proof,

anti-crease,

etc.)

f

.

Twelveshades (five dark, three medium,

and four light colors)

.

Overallquantity

0 D k sh'de -l

Total

=

180EoQ

6EoQ Icolor

1EoQ=350kgs

0 Medium

=> total kgs=

shades-2.5

63,000kgs

EoQI colo,

J

Lightshades-

6.25EoQIcolor

0 Rejectionrate-30/0 (overall)

0 Programanticipated in peakseason

.

Installed capacity = 3,500kgs/day(in three

eight hour shifts)

.

Therefore total program books about 20 days

worth of production; very lucrative


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.

Targetprice

=

250-275/kg

Probability of this order

through

=

0.80

.


comlllg

mind, was to propose a system of costing an order

that was more reflective of the current business

process see Exhibit 5 , and then re-evaluate the

quote to be sent to the buyer. He asked the process

managers to work out different scenarios using SAP,

and come up with the numbers see Exhibit 6 .

o nd o was confident that the company

couldmeet the targetprice.The centralissue,to his

Cost flow existing that mimicked

the current process flow

Overheads

.

Productdevelopment costs

. Communicationosts

.

CommonUtilities

. Support costs

. Machinecosts

.

Capacity

Utilization/Efficiency

Were totaled and added / kg

of material delivered straight

to the bottom line

Cost flow as per the actual process flow

I Communication I

+

Capacity utilization/efficiency worked out.

Efficient schedules were profitable.

Overheads

.

Commonutilities

.

Support

costs

ere tot lled and

added / kg of material

delivered straight to

the bottom line

.

EOO defined

.

SAP used to calculate planned costs

. Calculatevariances

. Less lumpedoverheads whichreduces

cross subsidizations


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8

CHAPTER PRICING

..

Rs 2/kg

irect labor

Produ

Overheads

Rs6/kg

RsIS/kg

Rs30- 40/kg

-


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Arvind Mills Re Evaluating Profitability

8

CASEQUESTIONS

1. Whatpricing

ShouldArvindMillsresorto competition based

Whyorwhynot?

Areanydiscountingacticsavailableo

whynot?

ShouldhemarketingmanagementeamatArvindMillsattem

productseingoffered hemethodsfproduction ndthedQliveryystems?

programffectthesechanges?

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Arvind Mills Re-Evaluating Profitability